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Deloitte’s Insights for C-suite executives and board members provide information and resources to help address the challenges of managing risk for both value creation and protection, as well as increasing compliance requirements.

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Value Killers: What You Can Do to Understand and Prepare for Them

The last decade saw a number of events, from the global financial downturn to the euro crisis and the disruptive floods in Thailand, that impacted the shares of individual companies and at times whole markets. For some companies such events were value killers, creating significant losses, and not all were fortunate enough to rebound.

Edward Hida, Partner, Deloitte & Touch LLP

In The Value Killers Revisted: A Risk Management Studyfrom Deloitte LLP, authors Dr. Ajit Kambil, global research director for Deloitte’s CFO Program, and Edward T. Hida II, a partner at Deloitte & Touche LLP, and global leader of risk and capital management, analyzed the 1,000 largest global public companies for the period 2003 to 2012. Utilizing more than two million financial data points over 10 years, they calculated the magnitude of each company’s largest one-month loss (“loss event”). They then analyzed hundreds of articles and reports on these loss events to understand the reasons for the 142 most severe drops in company value (to identify 100 company names). The latest study, which builds on an earlier study that tracked losses in shareholder value from 1994 and 2003, also identified the value killers behind these major losses, as well as insights about key value killers.

“Our recent study showed that since 2003, almost 38% of these companies suffered share-price declines of more than 20% in a one-month period relative to the MSCI Global 1000 index in the same period. We call these dramatic losses ‘value-killer losses,’” says Dr. Kambil. “We also found that by the end of 2012, roughly 18% of these companies had not yet recovered their value-killer losses, while 18% waited over a year for their share prices to recover. And only 6% of the companies analyzed had a value loss relative to the MSCI index of less than 10% over the decade,” he adds.

Although many of the value-killer losses were concentrated in the finance, insurance, construction and raw-materials industries, the study found value-killer losses were prevalent across a wide range of industries. “Moreover, the individual value-killer events, while distinct, were often driven by similar underlying risks,” says Mr. Hida.

Dr. Ajit Kambil, Global Research Director, Deloitte CFO Program

One example of the damage a value killer event—or combination of events—can cause organizations involves a large company that confronted declining demand and prices for its products a few years ago and could not meet prior business-plan forecasts. The company reduced its go-forward revenue expectations, and had to initiate a restructuring of its operations and reductions in its workforce to focus on strengthening the balance sheet. On top of this, the company also announced that it would record material impairment charges. These factors, in turn, motivated a credit-rating agency to downgrade the company’s rating, citing the above factors. All of this led to a drop in share value of more than 40% within a few weeks.

“Value-killer losses often result from the interaction of a number of unpredictable factors and are rarely the outcome of just one issue,” says Mr. Hida. “When we analyzed the largest losses, almost 90% of companies were hurt by several risks working in concert even if triggered by a specific event,” he adds. “In other words, when bad things happen, they may occur as an unexpected bundle of correlated or uncorrelated events that add up to a significant value-killer loss.”

Top Drivers of Value Killer Share Declines

In all, the authors observed five major themes underlying the value killer losses:

1. High-impact, low-frequency risks trigger most value killers: The most notable trigger of value-killer risks was a high-impact, low-frequency event, often referred to as a black swan. Large industry- or economy-wide events such as the credit crisis or eurozone crisis drove the most value losses. These events often expose a company’s biggest strategic, operational or financial weakness, often triggering a further cascade of negative events for the company.

2. Correlated and interdependent risks. The study reveals nearly three-fourths of major loss events occurred due to correlated and interdependent risks. While a black-swan event may trigger a value loss, its magnitude is often amplified by interdependencies among a variety of risks in an organization. Interdependent risks were the key driver of value losses in the first report; the authors’ latest research reaffirms the importance of thinking about risk events not just in isolation but in terms of how a risk event may trigger other events within a company and escalate into a massive value loss. During this time the term “systemic risk” entered the broader lexicon as many companies in the financial services sector stood on the brink of collapse. Interdependencies between the financial-services industry, and other industries and companies dependent on financial services, made it critical to consider how the events and risks outside a company’s core industry–but still within its ecosystem of critical resources–can drive value.

3. Liquidity risk became more salient: The financial downturn made real or perceived weaknesses in a company’s balance sheet, and the potential inability to access capital, a much more salient driver of value losses. Since the financial downturn, highly leveraged companies without sufficient liquidity reserves were at greater risk of value loss than comparable firms with less leverage. In the face of rising costs and slowing demand, lack of liquidity was often a critical constraint on the company and a driver of value losses.

4. Unsuccessful M&A remained a critical value killer for select companies: As was found in the earlier study, unsuccessful M&A deals can be value killers for many different reasons. Deals can go bad due to incorrect valuations before the deal, failure to complete an announced deal, changed economic circumstances after the deal, or failure to capture anticipated synergies or effectively execute post-merger integration.

5. Culture, compensation and fraud risks as drivers of value losses: These risks arise when a company’s culture and compensation plans create incentives to commit fraud or encourage employee behaviors that increase the risks that are assumed by a company.

In addition to the above findings, the study revealed a few other categories of salient risks that drove value killer-like losses. These include cost overruns and political and sovereign policy risks. Lastly, one noteworthy finding was that instances of accounting fraud as a driver of value-killer losses–at the 100 companies that experienced the largest value-killer losses–was substantially lower this decade than in the previous decade.

Guarding Against Value Killers

While risks cannot be eliminated, companies can better prepare for them. Scenarios and models can be built to explore how companies will fare when confronted with a value-killer event, especially, high-impact, low-frequency events. Companies can stress-test their capacity to respond to different scenarios where a bundle of events—correlated or uncorrelated—occur concurrently. A risk-intelligent enterprise can build on the knowledge of prior value-killer risks to help identify, model and practice ways to manage and respond to existing and future value-killer risks.

“Scrutinizing value killers and pathways to losses can help frame better questions on how to sidestep or manage future risk events,” says Dr. Kambil. “While new surprises are always lurking around the corner, and the past is not necessarily a prelude to the future, by understanding the past we can more likely avoid repeating its mistakes.”